What Is Adjusted Basis?
Adjusted basis refers to a material change to the recorded initial cost of an asset or security after it has already been owned. Updating the original purchase cost by taking into account any increases or decreases to its value is primarily used to compute the capital gain or loss on a sale for tax purposes. In general, an adjustment that increases the cost basis will lower one's tax burden.
The adjusted basis may be contrasted with the unadjusted basis, which does not account for any changes to that cost over time.
Key Takeaways
- Adjusted basis refers to a change to the accounting cost of an asset or security when it was originally obtained.
- The basis must be adjusted so that accurate gain and loss records can be kept for return calculations and tax purposes.
- To calculate an asset's or security's adjusted basis, you simply take its purchase price and then add or subtract any changes to its initial recorded value.
- Capital gains tax is paid on the difference between the adjusted basis and the amount the asset or investment was sold for.
Understanding Adjusted Basis
The cost basis of an investment or asset is the initial recorded value paid to acquire it, including any associated taxes, commissions, and other expenses connected with the purchase. From the time it is bought to when it is sold, the period of ownership, events can then occur that increase or reduce this basis, such as spending money on improvements, capital expenditures (CAPEX), or general wear and tear.
In such cases, the price paid has to be adjusted so that accurate gain and loss records can be kept for return calculations and tax purposes. When the time comes for the asset or investment to be sold, the adjusted basis is used to calculate a capital gain or loss.
Important
Capital gains tax is paid on the difference between the adjusted basis and the amount the asset or investment was sold for.
When Adjusted Basis Occurs
1) The cost basis of a security, such as shares of stock, can sometimes be adjusted when certain events happen. For example, a dividend paid in the form of additional stock will cause an adjustment in the cost basis of the original shares. The cost basis of the original shares will also be adjusted in the event of a stock split or a capital distribution. Dividends paid by the issuing company in cash do not cause an adjusted basis.
2) When a person or company owns an asset such as a piece of heavy machinery or a house, depreciation can be claimed due to wear and tear on the asset. When depreciation is claimed, the cost basis of the asset changes. On the other side of the coin, improvements to an asset can also cause a reassessment of cost basis leading to a basis adjustment.
3) When a person passes away, their assets may be passed on to loved ones. After proper death protocols, the assets that are inherited by heirs receive a step-up in basis. This means all of the willed assets receive an adjusted basis that is valued as of the date of the deceased person's death. Passing on assets after death and the resulting adjusted basis can allow loved ones to sell assets that have been willed to them with little or no tax consequences.
Example
To calculate an asset's or security's adjusted basis, you simply take its purchase price and then add or subtract any changes to its value.
So, if, for instance, an asset was purchased for $10,000 and then sold a year later after registering $500 in depreciation and $1,000 being spent on enhancements, it would have an adjusted basis of $10,500: $10,000 - $500 + $1,000 = $10,500.
